Agricultural consequences of the eurozone crisis

The consequences of the decisions at the fateful Brussels summit on 9 December 2011 will take time to assess. Whether leaders did enough to calm the markets and allow eurozone governments to refinance their enormous debts next year at reasonable interest rates will be known relatively quickly. Many commentators feel that financial markets will not be impressed, and that the EU is facing into a prolonged depression in which the break-up of the eurozone is a real possibility.

The significance of the institutional changes implied by the creation of a new inner core of EU member states pledged to achieve greater fiscal integration will only be known over a longer time span. Whether Britain, by opposing a new treaty, has lost influence and will move towards the EU’s exit door is also still unclear.

EU agriculture and agricultural policy-making in the EU will not be immune to these momentous changes. Whether the CAP budget can be safeguarded in the negotiations for the next Multi-annual Financial Framework must be increasingly in doubt. The growing likelihood of an EU recession next year, possibly inducing further economic turmoil beyond the continent, will lower demand for agricultural output and could lead to another collapse in output prices. Difficulties in Europe’s banking sector will curtail credit to farmers and to the small and medium-sized enterprises which make up the bulk of the EU’s food industry. In an extreme scenario, the EU’s prized single market in agricultural and food products could come under threat.

Implications for the CAP budget 2014-2020

Stefan Tangermann has argued strongly that the Commission’s proposal for CAP funding in the 2014-2020 period does not recognise the need for austerity which member state budgets are grappling with. Net contributors (for example, in the letter from David Cameron to the President of the Commission in December 2010 but signed also by France, Germany, Netherlands and Finland) have called for a budget in which commitment appropriations do not exceed the 2013 level and with a growth rate below the rate of inflation, implying annual budgets decreasing in real terms and even more as a share of EU Gross National Income (GNI). The European Parliament had argued that freezing the MFF at the 2013 was not realistic and that at least a 5% increase in resources was required.

The starting point for the Commission proposal for the next multi-annual financial framework is commitment appropriations of €145.65 billion in 2013 (in 2011 prices), corresponding to 1.12% of EU GNI. Commitment appropriations in the MFF would fall in 2014 to €142.56 billion, gradually rising to €150.72 billion in 2020. However, additional extra-MFF expenditure would bring total commitments to €159.13 billion in the Commission proposal (all figures in 2011 prices). Using the Commission’s projected growth in GNI over the period, as a percentage of GNI, MFF commitment appropriations would fall from 1.08% in 2014 to 1.03% in 2020, averaging 1.05% over the period (these figures would be 1.13% in 2014, falling to 1.09% in 2020 and averaging 1.11% over the period if the extra-MFF expenditure is included). (All figures from the tables in the Commission’s MFF proposal COM(2011) 500).

The projected GNI shares are dependent on the Commission’s economic growth assumptions for the EU. The Commission regularly updates its growth forecasts which are used as an input into its various “European Semester” policy surveillance activities, such as the Annual Growth Surveys, Stability and Convergence Programmes, National Reform Programmes as well as the MFF projections.

The basis for the MFF projections was its assumption that GDP rates will fall from an average of 2¼% in the 1998-2007 period to 1½% in the 2011-2020 period, although with significant differences across countries. If growth were further weakened as a result of the eurozone crisis, then the MFF proposal (which is set in absolute amounts) could result in a situation where the EU budget started to grow as a percentage of EU GNI. This would further strengthen the hand of those member states seeking to reduce EU budget spending, and would put further pressure on the budget proposed for the CAP.

Outlook for economic activity

The recent OECD Economic Outlook no. 90 (published 28 November last) presented a sombre outlook for EU economic activity even while assuming that monetary policy remains very supportive, that sovereign debt and banking sector problems in the euro area are contained, and that excessive fiscal tightening will be avoided. It shows the eurozone in recession in the last quarter of this year and the first quarter of next year. It assumes that confidence will recover gradually in the second half of 2012 if it becomes clear that worst-case outcomes have been avoided (it refers to this as the muddling-through scenario).

The OECD Economic Outlook also examines a downside scenario which assumes that contagion from a disorderly sovereign debt restructuring, for instance in Greece, is widespread in the euro area. The scenario does not allow for the possibility of exit from the euro area, or for stronger expectations thereof, or for possible major discontinuities that might arise if any major financial institutions ceased to operate. It projects that, in this scenario, the level of output in the OECD economies would be 5% lower in 2013 than in the muddling through scenario. A change of this magnitude from the muddling-through baseline would be associated with a deep recession in the euro area, and also push the United States and Japan into recession. It would also give rise to strong disinflationary, or even deflationary, forces.

The Economic Outlook continues:

If everything came to a head, with governments and banking systems under extreme pressure in some or all of the vulnerable countries, the political fall-out would be dramatic and pressures for euro area exit could be intense. The establishment and likely large exchange rate changes of the new national currencies could imply large losses for debt and asset holders, including banks that could become insolvent. Such turbulence in Europe, with the massive wealth destruction, bankruptcies and a collapse in confidence in European integration and cooperation, would most likely result in a deep depression in both the exiting and remaining euro area countries as well as in the world economy.

The OECD study does not look at the implications of such scenarios for commodity prices, but it is at least plausible that we would see price falls for agricultural commodities similar to those that occurred in 2009 as economic activity collapsed in the wake of the Lehmann Brothers bank collapse in the United States.

Implications for the EU’s single market

It may seem strange to link the future of the single market with the eurozone crisis. After all, many EU members enjoy the benefits of the single market without adopting the euro. The legislation that underpins the single market will remain in place regardless of what happens to the euro. At least that is the hope, and the argument that David Cameron made explicitly in his press conference after the summit arguing that life in the EU, particularly the single market, will continue as normal.

Others disagree. The Polish Foreign Minister made an impassioned and remarkable speech in Berlin at the end of last month in which he appealed to Germany to take a more active role in helping the eurozone to survive (the speech ran as an op-ed in the Financial Times on Nov 28th last). Sikorski wrote: “The break up of the eurozone would be a crisis of apocalyptic proportions, going beyond our financial system.” He went on to suggest that the EU’s single market would be unlikely to survive such a trauma.

It is indeed very hard to imagine that we would see tariffs reintroduced on agricultural trade between EU members. But a few months ago, the idea that a eurozone member state might leave the euro was also unthinkable. A country forced to leave the eurozone, and faced with the calamitous contraction in economic activity that would result, might be very tempted to put in place what would be no doubt called temporary import surcharges (although the currency depreciation that would accompany exit from the euro zone would in itself provide a significant barrier to imports). The rise of nationalistic and populist sentiment in other countries particularly if unemployment (currently over 10% in the euro zone and almost 10% in the EU as a whole) continues to rise could also create a climate conducive to the return of protectionism.

At present, there may be only a very small probability of the break-up of the single market. But there is no doubt that this is a dangerous time for Europe. EU agricultural policy, and the food and farming sectors that it regulates and supports, is unlikely to remain unaffected.

Update added 17 December 2011: The AgriCommodities Research Team at Rabobank have just produced their end-of-year forecast for agricultural commodities in 2012 which takes a more relaxed view of the impact of the eurozone crisis and recession on agricultural market prices. According to Rabobank, “slowing global economic growth in 2012 will only have a modest impact on agri commodity prices as resilident emerging-market demand offsets anaemic growth expectations in the developed world”. They go on to note that supply is forecast to be historically tight for many agri commodities, and supply-side concerns will remain a supportive factor for most markets. They conclude:

In general, recessions do not impact agri commodities uniformly. In fact, supply dynamics are much more important for price movements, and this is expected to be the case in the event of a recession in 2012. Recessions have little effect on the demand side in the developed world and economic contractions do not generally impact supply, which is much more dependent on long-term prices and weather. The downside risk for commodities is much larger if a sizeable slowdown in emerging markets occurs, as this is the source for much of the expected expansion in consumption.

This post was written by Alan Matthews

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